Why turning telecom carriers into infrastructure utilities is great for shareholders and the unconnected
Four days from now an unprecedented event will take place in Italy…
The breakup of an incumbent telecom carrier driven by market forces and not anti trust regulations
1. What is meant by “market forces”?
- There is money to be made in buying stocks of telecom carriers (like Telecom Italia) at prevailing stock prices, selling their assets and distributing the resulting cash proceeds to stock holders. To understand this phenomenon, notice the difference between Enterprise Value (value of stock + debt) and Total Assets (net book value as reported on the balance sheet) of a telecom carrier.
- Separating infrastructure from services has consistently delivered better returns for investors than integrated telecom carriers. For example, investors of INWIT (infrastructure only subsidiary of Telecom Italia) made money in the past 3 years whereas investors of Telecom Italia lost money.
- Stock market investors are willing to pay 2.5x more on average for each unit of cash flow in an infrastructure only entity (like INWIT) as opposed an integrated carrier (like Telecom Italia) because infrastructure only entities offer much more cash flow predictability.
2. What is unique about Italy?
- There was a catalyst: Enel (power utility in Italy) started deploying wholesale only fiber (“Open Fiber”)in 2015 and by 2018 market forces realized that Enel’s Open Fiber project will decimate Telecom Italia’s business because Enel can deploy fiber at a lower cost than Telecom Italia. This is because Enel has existing infrastructure and Rights of Way. Secondly, Enel was able to secure financing because it positioned its project as “infra-only” under predictable long-term contracts.
- There was an activist: Elliot Management, a hedge fund in New York, purchased a 10% stake in Telecom Italia and teamed up with Cassa Depositi e Prestit (5% owner of Telecom Italia and Enel’s 50% joint venture partner in Open Fiber). Elliot and CDP won shareholder support to fire Telecom Italia’s CEO, appoint a different CEO and change members of the board as well. Elliot won the support from other stock holders by offering the following proposal (paraphrasing obviously). The fate of Telecom Italia will be decided in a board meeting scheduled for March 29 2019 so stay tuned!
- There was a bankable business model: Enel Open Fiber will connect 13 out of 23 million homes in Italy with wholesale only last mile fiber. This means that Enel will charge a fixed fee for making fiber infrastructure available and let the private sector compete for offering services. Base case estimates show a healthy mid-teens IRR for Open Fiber. Reorganizing Telecom Italia’s fixed line business in line with Open Fiber’s business model will help Telecom Italia shareholders make returns (as opposed to lose money). For context, Telecom Italia’s revenues declined from $32 billion (2013) to $ $21 billion (2018).
- There is a BIG future opportunity in Latin America: Enel is present in Brazil, owns a 21% stake in a Latin American fiber operator called Ufinet, with a call option to buy all of Ufinet. TIM Brazil is the second largest integrated telecom carrier in Brazil. With Telecom Italia under Elliot’s control, and a winning formula of converting telecom carriers into infrastructure utilities already experienced in Italy, the experience in Italy could be replicated in Brazil.
3. Why is this good for connecting the unconnected?
- Telecom carriers are not incentivized to bridge the digital divide: Telecom carriers have built ~5 million towers which provide coverage to ~97% of the population. However, only 10% of these towers contribute to over 50% of revenues. Such towers are in city centers. Telecom carriers make their money in urban areas and are not naturally incentivized to upgrade networks elsewhere. Infrastructure utilities on the other hand can design longer term contracts needed to build fiber everywhere, especially away from urban centers.
- The world needs more open access fiber: Optical fiber is the most suitable technology to create bandwidth abundance because it has virtually unlimited capacity and the fiber cable itself has become a commodity. If fiber becomes pervasive and open access, cost of connectivity will fall and the digital divide will get bridged. Large scale fiber deployments can be financed if fiber is treated like other infrastructure, for example a power plant or a toll road.
- Electric utilities like Enel are well placed to deploy fiber: Retrofitting fiber on power lines utilizes existing Rights of Way is technically feasible and can lower cost of deployment to as low as $4/meter (compared to an average deployment cost of over $30/meter). More importantly, the electrical grid is about 13x more pervasive than the existing global fiber network (see the image from Uganda below).
- Separating infrastructure from services lowers connectivity price: When infrastructure is separated from services, entry barriers for communication services become lower which results in lower consumer prices. The best example of this phenomenon is observed in a small American town called Ammon, Idaho. Ammon took a creative approach of deploying a Software Defined Network. Ammon has a population of only 15,000 people yet this separation of infra from services has made it feasible for 3 separate ISPs to compete for Ammon customers. (see video here).
4. How to reduce bandwidth disparity across the world?
- Encourage more Open Fiber like deployments by making infrastructure maps (power lines, cell towers, fiber) publicly available to business model innovators.
- Create an investment fund dedicated to financing wholesale only open access fiber deployments.
- Facilitate transformation of telecom carriers into infrastructure only utilities in partnership with investors like Elliot Management.
- Develop Software Defined Networking capabilities to create networks similar to the one in Ammon, Idaho to make it seamless for customers to access infrastructure.
To learn more about the “Ammon Model” see this video
Open Fiber business model + Ammon bandwidth distribution model + Investment fund willing to back wholesale only fiber deployments + a telecom carrier willing to transform into an infrastructure utility = CONNECTIVITY AWESOMENESS!